United Student Aid Funds Inc. V. Francisco Espinoza
United States Supreme Court case 08-1134
Oral arguments December 1, 2009
Can a student loan be discharged, even in part, in a Chapter 13 plan without a finding of “undue hardship”? More broadly, how final is a confirmed chapter 13 plan? The United States Supreme Court will be answering these questions in a rare bankruptcy case appeal.
The facts of the case are simple. In 1988, Francisco Espinoza borrowed $13,050 in a student loan. In 1992, he filed a Chapter 13 case in Arizona, listing that loan as his only debt. His Chapter 13 plan called for paying off the student loan in full, without interest. The plan specifically stated that the student loan would be fully satisfied at the completion of the plan, and a copy of the plan was mailed to the student loan bank at their payment address. The student loan creditor did not object plan, and the bankruptcy court confirmed it. The creditor filed a claim for $17,832.15, and the Chapter 13 trustee filed an objection to the claim, beyond the principal amount of $13,250. Apparently, the creditor did not oppose the objection to claim. The plan was completed, and the bankruptcy court issued a bankruptcy discharge. The creditor did not oppose the discharge, or appeal any of these bankruptcy decisions.
Two years after he received his bankruptcy discharge, the student loan creditor started collecting on the unpaid interest. The debtor moved in bankruptcy court to have the creditor found in contempt of court for violating the discharge order. He argued that the interest on his student loans was fully discharged: the Chapter 13 plan specifically said so, the creditor received copy the plan, the creditor did not object to the plan or appeal the plan confirmation order, and the creditor did not object to the discharge or appeal the discharge order. The bankruptcy court agreed with the debtor that the student loan, including interest, was fully discharged.
The creditor appealed to District Court, which reversed the bankruptcy court decision. The debtor then appealed to the United States Court of Appeals for the Ninth Circuit, which upheld in the Bankruptcy Court and reversed the District Court. The United States Supreme Court agreed to hear the case, and oral arguments took place December 1, 2009.
The position of the parties is fairly simple. The student loan creditor argues that student loans are never discharged no matter what the plan says and no matter what the bankruptcy court says. The Bankruptcy Code is self-executing on the point and an order to the contrary is void. The bankruptcy court has no power to discharge a student loan absent a finding of “undue hardship” following a bankruptcy adversary proceeding. The debtor’s position is that by failing to object to the plan, the confirmation order, or the discharge order, the creditor has waived its rights to object to the discharge of the student loan.
Circuit Courts of Appeal are divided on this issue, or, more specifically, the Ninth Circuit’s 2008 decision, Espinosa v. United Student Aid Fund, Inc., 530 F.3d 895 differs significantly from two other circuits. The 10th Circuit in In re Mersmann, 505 F.3d 1033 (2007) and the Second Circuit in Whelton v. Educ. Credit Mgmt. Corp., 432 F.3d 150 (2005) both came out the other way.
Oral Arguments: The Supreme Court heard the case on December 1, 2009. The justices appeared to believe the bankruptcy court erred in allowing a partial discharge of student loans absent a finding of undo hardship. The question was what should be done with bankruptcy court orders entered in error. The student loan creditor emphasized in its brief that other claims, such as child support or recent income taxes, might be discharged erroneously in a similar chapter 13 plan, absent objection. The debtor’s attorney admitted as much to Justice Ginsburg. On the other hand, the creditor’s attorney faced skepticism from Justices Ginsburg, Kennedy and Stevens in claiming that the student loan creditor could never waive its rights to an undo hardship hearing. Justices Sotomayor and Breyer questioned whether a court order could be considered void unless the court lacked jurisdiction. Justice Alito raised the prospect that the debtor’s attorney might be sanctioned for including a provision like this in a Chapter 13 plan, and Justices Bryer and Scalia were sympathetic to this argument.
Student loan dischargeability: One thing just about everyone seems to know about bankruptcy is that student loans are not dischargeable. Starting in the 1970’s, Congress has increasingly restricted the dischargeability of student loans. In 1976, student loans were made dischargeable in bankruptcy only after five years had passed from when the first payment was due. That period was extended to seven years in 1990 (and applied to Chapter 13 as well), and the time limit was eliminated altogether in 1998. The original purpose of making government-backed student loans nondischargeable was to protect the taxpayer from huge student loan losses. In 2005, the definition of student loans was expanded to include private for-profit loans, so even those loans not guaranteed or subsidized by the public are now protected from bankruptcy discharge.
Student loans may be discharged in bankruptcy if they are an “undue hardship“. The primary case as to what constitutes an undue hardship is In re Brunner, 831 F.2d 395, 396 (2d Cir. 1987). Under a Brunner analysis, the debtor must pass a very difficult three-part test. The debtor must show that he or she cannot maintain a “minimal” standard of living for his or her family based on current income and expenses, that the situation is likely to persist for a significant period of time, and that the debtor has made a “good faith” effort to repay the loan. It is the second prong of this test, showing that the situation is unlikely to change in the future, that is extremely difficult to prove, absent some permanent disability preventing employment.
When Brunner was decided in 1987, student loans could be discharged after five years from when they were first due and payable, so perhaps the decision was not considered all that significant. However, since then the time limit has been eliminated, so the Brunner test has become the only way to discharge these loans.
Student loans in the Western District of New York: Burnner, as a Second Circuit case, must be followed by the Western District of New York, a Second Circuit court. Local decisions show how difficult Brunner is when implemented.
The debtor in In Re Martin, Bk 93-20701, AP 93-2163 (Judge Ninfo; Bankr. W.D.N.Y. 1994) was granted a hardship discharge after showing serious long-term physical disabilities. But the debtor in In Re Kraft, 161 B.R. 82 (Judge Kaplan, Bankr. W.D.N.Y. 1993), a poorly-paid bus driver with some physical infirmities was not allowed to discharge her student loan, as she had not waited long enough to see whether her future employment would be more lucrative.
The debtor in In Re Maulin,190 B.R. 153 (Judge Bucki; Bankr. W.D.N.Y. 1995) attempted a discharge one year after the loan became payable, having not made anyattempt to repay it; she was unsuccessful.
The mental stress of repaying student is not sufficient to justify discharge, if the betor has the financial ability to do so. In re N.M. 325 B.R. 507 (Judge Bucki; Bankr. W.D.N.Y. 2005). On the other hand, a debtor suffering from agoraphobia, which prevented her from earning more than a very modest income working at home, was found to pass the Brunner test. In re Armesto, Bk 02-10445, AP 02-1087 (Judge Bucki, Bankr. W.D.N.Y. 2003). A debtor suffering from bi-polar illness was similarly discharged. In re Douerty, 219 B.R. 665 (Judge Kaplan, bankr. W.D.N.Y. 1998)
One line of Wester District of New York student loan partial-discharge cases may be re-examined following the Espinoza ruling . In In Re Raimondo, 183 B.R. 677 (Bankr. W.D.N.Y. 1995), Judge Bucki ruled that the bankruptcy court could partially discharge a student loan, that it did not have to be an all-or-nothing result. This decision does not appear to have been appealed, and it continues to be followed by Judge Bucki (In re Davis, 336 B.R. 604 (Bankr. W.D.N.Y. 2006)) and others (In Re Barron, 264 B.R. 833 (Bankr. E.D.Tex. 2001), The partial-discharge approach has also been criticized (see In Re Pincus, 280 B.R. 303 (S.D.N.Y. 2002).